Yesterday, the Delaware Supreme Court issued its decision in Boardwalk Pipeline Partners v. Bandera Master Fund, (Del. 12/22). The Court reversed a 2021 Chancery Court decision which found that the general partner of a Master Limited Partnership (“MLP”) was liable for nearly $700 million in damages as a result of a breach of the partnership agreement involving willful misconduct that left the general partner exposed to unexculpated claims under the terms of that agreement.
The Supreme Court’s decision is likely to be an important one, both as a result of its deferential approach to a partnership agreement’s language conveying broad discretionary authority to the general partner, and because of a concurring opinion addressing the standard of review that Delaware courts should apply to a law firm’s legal opinion.
The case involved the permissibility of a general partner’s decision to exercise a contractual call right on the limited partners ownership interests provided under the terms of a MLP partnership agreement. The exercise of that right was conditioned upon the general partner’s receipt of a legal opinion concerning the impact of pending regulatory action by the Federal Energy Regulatory Commission on the company’s oil & gas pipeline business. Under the terms of the partnership agreement, exercise of the call right was also conditioned upon the general partner’s determination that the opinion of its counsel was acceptable. In order to assist in that determination, the general partner retained another law firm to shadow that counsel’s work and provide its own opinion on the reasonableness of relying on the first counsel’s opinion.
The plaintiffs alleged, among other things, that the general partner breached its obligations under the partnership agreement when it exercised the call right. After surviving a motion to dismiss, the case went to trial., and Vice Chancellor Laster ultimately held that the general partner breached the agreement because it did not satisfy the opinion-related conditions to the exercise of the call right. He held that the legal opinion did not reflect a good faith effort on the part of counsel to discern the relevant facts and apply professional judgment. Furthermore, because the determination that the opinion was acceptable was made by the general partner and not the MLP’s board, he concluded that it did not comply with the terms of the agreement.
The Vice Chancellor also found that general partner engaged in willful misconduct when it exercised the call right, and that the exculpatory provisions in the partnership agreement didn’t protect the general partner from liability for its actions.
The Supreme Court disagreed. The majority focused on the terms of the MLP agreement, and in particular the broad discretionary authority provided to the general partner. After rejecting the Chancery Court’s conclusion that the opinion should have been directed to the MLP board, it addressed the general partner’s right to rely on that opinion.
In particular, the Supreme Court noted that Section 7.10(b) of the agreement provided that the general partner was “conclusively presumed” to have acted in good faith when it relies on advice of counsel “as to matters that the General Partner reasonably believes to be within [counsel’s] professional or expert confidence.” The Court held that in the context of the broad powers given to an MLP’s sponsor under the Delaware Revised Uniform Limited Partnership Act and the clear disclosure provided to investors in the MLP concerning the authority of the general partner, that language meant exactly what it said:
Unlike a rebuttable presumption, Section 7.10(b)’s conclusive good faith presumption is, as its name denotes, conclusive. Interpreting a nearly identical provision in Gerber, this Court explained that “Section 7.10(b) is a contractual provision that establishes a procedure the general partner may use to conclusively establish that it met its contractual fiduciary duty.” In other words, once Section 7.10(b) is validly triggered through reliance on expert advice, good faith is “conclusively establish[ed]” and no longer subject to challenge.
Here, the Sole Member Board received the Skadden Opinion, followed its advice that it would be reasonable to accept the Baker Botts Opinion, and caused the call right exercise. The conclusive presumption was triggered and therefore required a finding of good faith by the Sole Member Board. In turn, the Sole Member Board’s good faith actions on behalf of the General Partner exculpate the General Partner from damages.
Earlier in what’s become an alarmingly lengthy blog, I mentioned that the concurring opinion addressed the Chancery Court approach to the legal opinion provided to the general partner. I can feel your eyes glazing over, so I think I’ll save that part of the decision for tomorrow.
The November-December Issue of the Deal Lawyers newsletter was just posted and sent to the printer. This month’s issue includes the following articles:
– Universal Proxy Puts Directors on Notice
– Controlling Stockholders: Managing Liquidity Conflicts and Other Special Benefits
The Deal Lawyers newsletter is always timely & topical – and something you can’t afford to be without in order to keep up with the rapid-fire developments in the world of M&A. If you don’t subscribe to Deal Lawyers, please email us at sales@ccrcorp.com or call us at 800-737-1271.
This Freshfields blog reviews the FTC & DOJ’s merger enforcement litigation efforts during 2022 and provides some suggestions about actions companies thinking about current and future transactions should take to enhance their position. The entire blog is worth reading, but one section that caught my eye addresses how companies are adapting to the new environment:
First, we are seeing parties to transactions prepare rigorously, both in their initial risk assessments and anticipating probes based on innovative and ambitious theories of harm, for example to counter alleged market definitions that are inconsistent with how the industries operate in practice and with verifiable facts.
Second, we are increasingly seeing parties contemplate “fix-it-first” or “litigate the fix” strategies, whereby parties attempt to remedy potential anticompetitive effects on their own—sometimes before filing for merger clearance when “fixing it first,” or after an investigation in the case of “litigating the fix.”
Third, we observe parties planning for longer timelines in deal documents, with long stop dates that extend for up to 24 months to account for in-depth investigations in both the US and globally, and for litigation. And finally, on the topic of litigation, we see companies not only accept the possibility of merger litigation but also account for it as part of their clearance strategy.
After reviewing 2022 case law, the blog concludes that while the antitrust agencies have taken an aggressive and often innovative approach, courts continue to demand that the agencies convincingly substantiate their allegations of competitive harms, and also continue to uphold established merger control precedents in response to the novel theories advanced by the FTC & DOJ.
Prior business dealings between a company’s controlling stockholder and members of a special committee evaluating a transaction with that controller can call into question the committee’s independence. But the Chancery Court’s recent decision in Ligos v. Tsuff, (Del. Ch.; 12/22) illustrates that prior relationships don’t inevitably result in a conclusion that a director is independent.
The case arose out of a going private transaction in which the target was acquired by an affiliate of its controlling stockholder. The plaintiff challenged the special committee’s independence based on the members ties to the controller and the mere presence of a controlling stockholder. As this excerpt from Shearman’s blog on the case indicates, Vice Chancellor Glasscock rejected those allegations and dismissed the claims against the special committee members:
After concluding that the Company’s Certificate of Incorporation exculpated the Special Committee members from all claims other than for breach of the duty of loyalty, the Court held that Plaintiff failed to assert facts suggesting that any of the Special Committee Defendants were interested in the Transaction. First, the Court rejected the notion that the mere presence of a controlling shareholder was sufficient, noting that the Special Committee members would cease to be directors after the merger closed.
The Court next concluded that Plaintiff failed to allege that any material or beneficial relationship existed between the controller and any Special Committee member. Finally, the Court found that Plaintiff failed to meet the high pleading standard to allege bad-faith conduct, finding no indication of an “intentional dereliction of duty.” Thus, even though the Court agreed that the final outcome in the transaction was “not great,” the Court found that the Special Committee Defendants had “acted vigorously” in negotiating the merger.
In concluding that no material relationship existed between the controller and any special committee member, Vice Chancellor Glasscock said that the relationships alleged by the plaintiff were attenuated. In that regard, the most significant relationship that the plaintiff alleged was one in which a director had been a long-term employee of another business owned by the controller. However, that employment relationship had terminated more than 20 years ago, and the only relationship that had continued since that time was his continuing service on the target’s board.
The relationships alleged with respect to the other special committee members were much weaker, and were essentially premised on their status as long-serving members of the target’s board. Under the circumstances, the Vice Chancellor concluded that the failure to allege that the members of the special committee had any expectations of future business dealings made the plaintiff’s argument about their lack of independence based on these ties unconvincing.
I recently blogged about the dust-up in Chancery Court between Masimo Corporation & Politan Capital Management over some aggressive amendments to Masimo’s advance notice bylaw adopted in response to Politan’s activist campaign. This Sidley memo takes a deep dive into the issues associated with the amendments adopted by Masimo, and offers the following guidance:
– Companies should not lose sight of the desirability of adopting or amending advance notice bylaws on a “clear day.” Adopting on a “rainy day” invites the specter of enhanced scrutiny review. Defensive bylaws adopted in the context of an activist campaign are more susceptible to review under a heightened degree of scrutiny.
– Adopting bylaw amendments that frustrate or preclude altogether shareholders’ ability to run a proxy contest increases the likelihood of this more onerous standard of review. The Delaware courts have stated that the clearest set of cases providing support for enjoining an advance notice bylaw involves a scenario in which a board, aware of an imminent proxy contest, adopts an advance notice bylaw so as to make compliance impossible or extremely difficult.
– When adopting advance notice bylaws, engage counsel with experience amending corporate bylaws for advance notice provisions. The considerations for the adoption of various bylaw provisions are rapidly evolving and will continue to do so for the foreseeable future.
Masimo’s bylaw amendments were adopted in response to the exigencies of a specific activist campaign, and at this point, there doesn’t appear to be much interest among S&P 500 companies in adopting similar changes to their own bylaws. Companies considering amendments to advance notice bylaws should be aware of the potential legal and investor relations downsides associated with an approach that might be deemed too aggressive by courts and investors.
According to this PitchBook article, the cooling M&A market has resulted in more extensive due diligence and, as this excerpt explains, a bit of a comeback for indemnity arrangements and meaningful escrows in PE deals:
Buyers have been taking more time to dig into a target’s financial standing and, in some cases, have been negotiating stronger indemnity provisions to protect themselves against downside risks facing the assets they are looking to buy, lawyers involved in private equity deals said.
In recent months, investors have been more often advocating for provisions to indemnify themselves from losses that could arise from specific liabilities discovered during the negotiation and due diligence process.
To backstop these indemnities, sellers sometimes set up a separate escrow to withhold proceeds from the sale for a set period of time. The funds in the escrow could amount to between 7.5% to 12.5% of the purchase price, according to Morley Fortier III, a partner at law firm Reed Smith. In the case when the seller is an operating business and has sufficient assets to cover the liability, the buyer may not require a separate escrow.
The article notes that in recent years, it has become very unusual for buyers participating in a competitive process to require an indemnity provision seeking recourse from a PE seller, according to Fortier. Buyers in those deals have typically been limited to recovery under the RWI policy. However, as the market cools, buyers are becoming more attuned to risk allocation during the negotiation process, and that is being reflected in the indemnity and escrow arrangements they’re negotiating.
Several recent Delaware decisions have addressed the potential liability of third parties for aiding & abetting breaches of fiduciary duties, but in Atlantic NWI v. The Carlyle Group, (Del. Ch.; 10/22), the Chancery Court addressed the distinction between the elements of an aiding & abetting claim and the elements of another claim sometimes asserted against third parties in M&A transactions – tortious interference with a contract.
The case arose out of an alleged breach of a joint venture agreement entered into by the plaintiff with an entity called REDCO Fund 1 Manager. Under the terms of the JV, which took the form of a jointly owned LLC, REDCO agreed to seek out exclusive real estate investment opportunities for the plaintiff, but the plaintiff alleged that REDCO was presenting competing opportunities to Carlyle. As a result, the plaintiff (which settled its claims against REDCO), sued Carlyle for tortious interference and for aiding and abetting REDCO’s purported breach of fiduciary duty under the LLC agreement.
Vice Chancellor Glasscock dismissed the aiding & abetting claim, but allowed the tortious interference claim to move forward. This excerpt from Sidley’s recent blog on the decision explains the Vice Chancellor’s reasoning:
Tortious Interference. Atlantic claimed Carlyle interfered with the joint venture agreement by contracting with and providing material consideration to REDCO to receive real estate opportunities, causing REDCO to breach. The Vice Chancellor permitted this claim to go forward. Tortious interference with a contractual relationship requires a showing of five elements: (a) the existence of a contract, (b) that the defendant knew about, (c) an intentional act by defendant that is significant in causing its breach, (d) without justification, and (e) which causes injury. Atlantic needed only to “aver[ ] generally” that Carlyle acted with knowledge in the pleading stage under this “liberal knowledge standard,” and the complaint alleged facts from which the Vice Chancellor could infer that Carlyle knew REDCO would breach its contract by working with Carlyle.
Aiding and Abetting the Breach of a Fiduciary Duty Through the same actions, Atlantic claimed Carlyle aided and abetted REDCO’s breach of its duty of loyalty to the joint venture. Aiding and abetting the breach of a fiduciary duty requires that (a) a fiduciary relationship existed, (b) the fiduciary breached its duty, (c) the non-fiduciary knowingly participated in that breach, and (d) damages to the plaintiff resulted from the concerted actions of the defendant and the fiduciary. The knowledge standard is a “stringent” one, requiring the plaintiff to allege specifics facts demonstrating the defendant had actual or constructive knowledge of the specific fiduciary duties, and the Vice Chancellor found it had not been adequately alleged here.
The Vice Chancellor explained that the differing knowledge standards applicable to the claims arise out of policy considerations relating to which party was in the best position to prevent their own breach. When it comes tortious interference, once the third party knows about the contract, it can decide on its own whether to take actions that interfere with it. In contrast, the person in the best position to know what fiduciary duties require is the person subject to those duties.
This case gives me flashbacks to all that “cheapest cost avoider” stuff that we all heard about ad nauseam in law school. I’m sure all the law & economics profs can’t wait to dig into this one!
Yesterday, the FTC voted to file an administrative complaint to block Microsoft’s proposed acquisition of video game titan Activision-Blizzard. According to the FTC’s press release, Microsoft “has already shown that it can and will withhold content from its gaming rivals,” and this excerpt says that was a big factor in the decision to oppose the deal:
Activision is one of only a very small number of top video game developers in the world that create and publish high-quality video games for multiple devices, including video game consoles, PCs, and mobile devices. It produces some of the most iconic and popular video game titles, including Call of Duty, World of Warcraft, Diablo, and Overwatch, and has millions of monthly active users around the world, according to the FTC’s complaint. Activision currently has a strategy of offering its games on many devices regardless of producer.
But that could change if the deal is allowed to proceed. With control over Activision’s blockbuster franchises, Microsoft would have both the means and motive to harm competition by manipulating Activision’s pricing, degrading Activision’s game quality or player experience on rival consoles and gaming services, changing the terms and timing of access to Activision’s content, or withholding content from competitors entirely, resulting in harm to consumers.
The FTC voted 3-1 to initiate this action, with Commissioner Wilson dissenting. As Axios pointed out, it’s worth noting that the FTC filed the case in its own administrative court and isn’t seeking a preliminary injunction, which means that the parties would still theoretically be able to close the deal, assuming that they’re willing to risk subsequently having it unwound – and assuming that no other regulator puts the kibosh on it.
If you’re interested in what obligations the parties have under the merger agreement when it comes to regulatory issues, check out this blog that I wrote at the time the deal was signed up.
Earlier this week, the Corp Fin Staff issued three new CDIs on universal proxy. Dave Lynn posted this blog about them on TheCorporateCounsel.net:
Yesterday, the Staff published three new Proxy Rules and Schedule 14A Compliance and Disclosure Interpretations addressing the new universal proxy rules. Two of the new CDIs deal with the company’s obligations when a dissident shareholder’s nominees are rejected based on advance notice bylaw requirements, and one of the CDIs makes the point that a dissident must provide its own proxy card as part of its meaningful solicitation efforts and not just rely on the company’s proxy card. The new CDIs are as follows:
Question 139.04
Question: A registrant receives director nominations from a dissident shareholder purporting to nominate candidates for election to the registrant’s board of directors at an upcoming annual meeting. The registrant, however, determines that the nominations are invalid due to the dissident shareholder’s failure to comply with its advance notice bylaw requirements. Must the registrant include the names of the dissident shareholder’s nominees on its proxy card pursuant to Rule 14a-19(e)(1) under these circumstances?
Answer: No. Only duly nominated candidates are required to be included on a universal proxy card. See Release No. 34-93596 (Nov. 17, 2021) (noting that universal proxy cards “must include the names of all duly nominated director candidates presented for election by any party…”, and explaining that “[a] duly nominated director candidate is a candidate whose nomination satisfies the requirements of any applicable state or foreign law provision and a registrant’s governing documents as they relate to director nominations”). If the registrant determines, in accordance with state or foreign law, that the dissident shareholder’s nominations do not comply with its advance notice bylaw requirements, then it can omit the dissident shareholder’s nominees from its proxy card. [December 6, 2022]
Question 139.05
Question: A registrant determines that a dissident shareholder’s director nominations do not comply with its advance notice bylaw requirements and excludes the dissident shareholder’s nominees from its proxy card. The dissident shareholder then initiates litigation challenging the registrant’s determination regarding the validity of the director nominations. Under these factual circumstances, what are the registrant’s obligations with respect to its proxy statement disclosures and solicitation efforts?
Answer: The registrant must disclose in its proxy statement its determination that the dissident shareholder’s director nominations are invalid, a brief description of the basis for that determination, the fact that the dissident shareholder initiated litigation challenging the determination, and the potential implications (including any risks to the registrant or its shareholders) if the dissident shareholder’s nominations are ultimately deemed to be valid.
If a registrant furnishes proxy cards that do not include the dissident shareholder’s director candidates and a court subsequently determines that the dissident shareholder’s candidates are duly nominated, then the registrant is obligated under Rule 14a-19 to furnish universal proxy cards with the dissident shareholder’s candidates. Accordingly, it should discard any previously-furnished proxy cards that it received. The registrant also should ensure that shareholders are provided with sufficient time to receive and cast their votes on the universal proxy cards prior to the shareholder meeting, including, if necessary, through the postponement or adjournment of the meeting. [December 6, 2022]
Question 139.06
Question: Can a dissident shareholder conducting a non-exempt solicitation in support of its own director nominees simply file a proxy statement on EDGAR, avoid providing its own proxy card, and instead rely exclusively on the registrant’s proxy card to seek to have its director nominees elected?
Answer: No. Rule 14a-19(e) requires each soliciting party in a director election contest to use a universal proxy card that includes the names of all director candidates, including those nominated by other soliciting parties and proxy access nominees. Rule 14a-19(a)(3) further requires a dissident shareholder to solicit holders of at least 67% of the voting power of shares entitled to vote on the director election contest and to include a representation to that effect in its proxy statement. This requirement is intended to prevent a dissident shareholder from capitalizing on the inclusion of its nominees on the registrant’s universal proxy card without undertaking meaningful solicitation efforts. See Release No. 34-93596 (Nov. 17, 2021). A dissident shareholder would fail to comply with these rules if it does not furnish its own universal proxy cards to holders of at least 67% of the voting power through permitted methods of delivering proxy materials (such as the Rule 14a-16 “notice and access” method). [December 6, 2022]
Our latest Deal Lawyers Download podcast features my interview with Georgeson Managing Director Ed Greene about how companies are preparing for the first proxy season under the universal proxy (UPC) rules. Topics addressed in this 10-minute podcast include:
– How implementation of UPC may influence activism and the upcoming proxy season
– Companies’ preparations for the new regime and additional actions they should be taking
– Activists’ responses to UPC and what we might expect as proxy season draws closer
– The influence that UPC might have had on recent years’ proxy contests
If you have something you’d like to talk about, please feel free to reach out to me via email at john@thecorporatecounsel.net. I’m wide open when it comes to topics – an interesting new judicial decision, other legal or market developments, best practices, war stories, tips on handling deal issues, interesting side gigs, or anything else you think might be of interest to the members of our community are all fair game.